Voluntary administration – the first 18 months

Voluntary administration was introduced to New Zealand about 18 months ago. As of 28 April 2009, 42 companies had entered voluntary administration, with 16 of these companies entering a deed of company arrangement. This Brief Counsel examines New Zealand's experience with voluntary administration.

The deeds of company arrangement (DOCAs) can be broken into two main categories. The majority of DOCAs involve creditors agreeing to be paid on a pro-rata basis and discharging some or all of their enforcement rights. Less common are DOCAs where creditors suspend their enforcement rights.

New funds have been injected into over half of the companies that have executed DOCAs. These funds have come from directors, shareholders or related companies. Unsurprisingly, there is a correlation between the injection of new funds and attempts to release from liability the party who injected the funds.

Aspects of the voluntary administration (VA) regime have been considered by the Court five times in New Zealand. The Court has approached VA with a swift, liberal and pragmatic approach.

The numbers

As at 28 April 2009, 42 companies had entered VA, of which 16 had signed a DOCA.1 In two cases, the DOCA covered multiple companies, so there have been 13 DOCAs signed in New Zealand. Every company that went into VA but failed to execute a DOCA at the watershed meeting is either in liquidation or in liquidation and receivership.

The VA experience has been well spread across insolvency practitioners. Practitioners from 18 different firms have been appointed voluntary administrators, with nine of those firms having more than one appointment. Practitioners from only four firms have acted on more than three administrations.

Practitioners from seven different insolvency firms have been appointed as deed administrators. Only three firms have had more than one deed administrator appointment, with only one firm administering more than two DOCAs. In one instance, the deed administrator was a practitioner from an Australian firm, as the company in question was a New Zealand subsidiary of an Australian company also in distress. In every case, the deed administrator had been the voluntary administrator.

The relatively low number of companies entering VA in New Zealand is concerning. In Australia, on which New Zealand’s regime is based, hundreds of companies enter VA every month.2 Even taking into account Australia’s larger economy, the numbers show that vastly more companies go into VA in Australia.

The DOCAs

Perhaps surprisingly, the number of companies entering into DOCAs, as a proportion of the companies entering VA, is slightly higher in New Zealand than in Australia.3 Excluding the companies that are presently in VA, a DOCA has been executed 44% of the time in New Zealand, compared with 33% of the time in Australia. However, VA is still in its early days in New Zealand and these figures have been derived from a low statistical base.

Our analysis of the 13 DOCAs has identified the following trends and features.

Compromise or rescheduling?

A majority of the DOCAs involve pro-rata payments to creditors in exchange for the satisfaction and discharge of all debts or claims due or payable to the creditor.

These DOCAs establish a fund into which various assets, such as money from bank accounts and contributions from directors, shareholders and related parties are collected. The recovery to the creditors represents the total amount collected by the deed administrator by that process, and it is fairly clear from most DOCAs that this amount is not expected to be a full repayment.

Clause 5 of Schedule 1 to the Companies (Voluntary Administration) Regulations 2007 provides that each creditor accepts that creditor’s entitlement under the DOCA in full satisfaction and complete discharge of all debts and claims due or payable to the creditor. Unless that default provision is altered by the DOCA itself, either expressly or impliedly, the debt will not survive the moratorium period.

The alternative is debt rescheduling. This involves creditors agreeing not to make claims against the company for the period of the DOCA. The creditors may also receive payments during the moratorium, by the mechanism just described, but the expectation is that the debt will be repaid in full, either through the DOCA or after its operation. This is much less common, but the approach has been used.

Director, shareholder and related party contributions

Eight DOCAs have provided that a director, shareholder or related company will contribute to the pool of assets. Some amounts have been modest. In two cases, the directors agreed to pay in $5,000 and $35,000 respectively. In another instance, the director shareholders agreed to pay the net proceeds from the sale of their house.Related companies have also agreed to contribute funds under a DOCA. Examples include:

a shareholder company injected $250,000 as a contribution towards the outstanding debts

a related company agreed to pay a total of $400,000 in two instalments, as well as agreeing to meet the claims of the minor creditors. The related company gave a general security agreement to secure these obligations

a payment by the franchise owner was described as a "brand support payment", and

a shareholder company agreed to contribute the proceeds of sale of its shares in the company, along with an additional cash payment.

Contributions have been made by certain creditors agreeing to a term in the DOCA that prevents the creditors making claims against the deed fund. We are aware of at least one instance of a creditor being partially subordinated in this way, without its consent.

These payments and contributions represent advantages to creditors that would not have been available under a liquidation. However, it is difficult to assess from the DOCAs the extent to which they represent genuine new money or new capital to enable the business to continue trading and to improve its fortunes. In many cases it does appear that the contributions have been made to avoid an insolvent liquidation, but without any expectation that the company or its business will continue.

Directors apparently being released from liability

At least five DOCAs have purported to prevent creditors bound by the DOCA from pursuing directors or shareholders of a company who have provided guarantees for company indebtedness, without leave of the Court. Is such a clause effective?

Section 239ACW provides that a DOCA releases the company from a debt only in so far as the DOCA provides for the release and the creditor is bound by the deed. It expressly states that any release of the company’s indebtedness under a DOCA does not affect the liability of a guarantor or person who has indemnified the creditor against default by the company.

In Australia, the Courts have stated quite clearly that the DOCA may only deal with company property, and therefore cannot exempt guarantors from their obligations to guarantee company indebtedness.4 Put another way, the mechanism that enables the majority to bind the minority can only be used to bind creditors in respect of claims against the company, and not claims against third parties.

However, if a creditor with a personal guarantee votes in favour of a DOCA that prevents creditors pursuing guarantors, arguably that creditor has agreed to release the guarantor, or waive its rights to enforce the guarantee.

It follows that, as the Australian Courts have decided, guarantors may be contingent creditors, and should be allowed to lodge claims in the VA.

Disclosing the DOCA

Under section 239AEB(1)(b), companies in VA must set out in every document issued or signed by the company the words “Subject to Deed of Company Arrangement”. These words do not appear in a search of the Companies Office website. It is necessary to search the list of documents registered against the company, and then to read the deed itself, to discover if the company is still operating under a DOCA. We think that is potentially confusing and would hope that a clearer notification can be made on the Register.

Judicial consideration

In New Zealand, the Court has considered the VA regime five times. These cases demonstrate a liberal and benevolent attitude to granting applications to appoint administrators, a willingness to resolve such applications promptly and judicial enthusiasm towards VA. A striking feature of all cases to date has been the speed with which the Court has engaged, enabling a commercially pragmatic course to be adopted.

In Icon Digital Entertainment Limited v Westpac New Zealand Limited,5 the Court granted the application to appoint administrators who were otherwise disqualified from appointment by reason of their prior connection with Icon and Westpac. Although the application was granted, extra cost, uncertainty and delay was caused by the necessity to make this application.

In Strategic Options Limited v Swordfish Lodge Management Limited,6 the applicant sought the appointment of administrators to take control of a hotel business. The Court enquired whether the administration would result in a better return for creditors than immediate liquidation. The Court interpreted the requirement for “a better return to shareholders” broadly, despite the lack of hard financial information. On balance, the Court decided that the grounds had been made out and granted the application to appoint administrators.

In Jennian Services Limited v Jennian Homes North Shore Limited,7 Jennian Services Limited applied to have the company placed into VA so that the company’s business, including the franchise, could be sold to a third party. The Court granted the order on the basis that a liquidation of the company would prejudice the sale of the business to a third party and it must therefore follow that an administration would result in a better return to creditors than liquidation.

In Maxim Group Limited v Jones Publishing Limited,8 an application was made for permission to continue a proceeding for breach of contract, while the company was in administration under section 239 ABE of the Companies Act 1993. The Court denied this application for a number of reasons, which, taken as a whole, reinforce the idea that the Courts are reluctant to impinge on the “breathing space” or “moratorium” from claims commencing from the time of appointment of administrator.

In Nylex (New Zealand) Limited (Administrators Appointed and In Receivership) and Anor,9 an application was made to extend the statutory time period of 20 working days from the date of the commencement of the administration to the watershed meeting. While the Court recognised care should be taken when determining whether to grant applications for extending time, the Court felt that it was appropriate in the circumstances of this case. This was a case where “complexity reigned” and the Administrator could not make a proper assessment of the company within the time prescribed by statute.

Conclusion

VA can be a powerful tool to deal with distressed companies because it provides flexibility and can be tailored to fit individual circumstances. While the use of VA has been disappointing, the regime has great potential, as recognised by the Courts’ willingness to promote and assist the regime, and the varied approaches to realisation, rescheduling and restructuring in the relatively few DOCAs to date.

Nevertheless, there are a number of amendments which should be made to the regime. These amendments will be discussed in a future edition of Brief Counsel.

Our thanks to Paul Appleyard, solicitor, for writing this edition of Brief Counsel.

Footnotes

These figures are based on data provided by the Companies Office and supplemented by our own searches of the Companies Register.

In August of 2007, for example, 229 voluntary administrations. Voluntary Administration: The Australian Experience, Companies and Securities Law Bulletin April 2008, Karen O’Flynn and Ray Mainsbridge, at 35